Canadian banks are scoring back-to-back record earnings, beating big U.S. lenders on profitability, productivity and dividend yields. They still can’t outperform U.S. banks on the stock market.

Toronto-Dominion Bank, Royal Bank of Canada and the nation’s other six large lenders collectively boosted profit 10 per cent to a record $11.7 billion in the fiscal third quarter. Still, that’s no match for a U.S. economy seen having more runway than Canada, thanks in part to President Donald Trump’s tax cuts.

Canada’s S&P/TSX Commercial Banks Index has gained 13 per cent in the past 12 months, lagging the 21-per-cent increase of the U.S. KBW Bank Index.

“Canadian banks are run well and everything, but where they’re sitting in our view is not as attractive as where our U.S. banks are in terms of opportunity,” said Tony Scherrer, director of research and portfolio manager with Seattle-based Smead Capital Management.

U.S. banks are well positioned for a lending revival fueled by a strong U.S. economy and a millennial generation approaching their home-buying years — an emerging opportunity as lending in Canada slows, Scherrer said. “They’re ripe and ready and able to lend, but we’re in the very early innings.”

Nafta uncertainty

U.S. banks — and even some Canadian ones with U.S. operations — are also getting a boost from U.S. tax cuts signed into law in December. The lower tax rates are expected to fuel annual profit gains at Wall Street’s biggest banks by more than $10 billion. Lower tax rates helped the six giant U.S. banks — JPMorgan Chase & Co., Bank of America Corp., Wells Fargo & Co., Citigroup Inc., Goldman Sachs Group Inc. and Morgan Stanley — churn out more than $29 billion in net income in each of this year’s first two quarters.

Canadian bank executives cite economic reasons for the disconnect. The U.S. economy is expected to expand 2.9 per cent this year and 2.5 per cent next year, outpacing forecasts of 2 per cent for Canada this year and 1.9 per cent in 2019, according to economists.

Uncertainty surrounding the renegotiation of the North American Free Trade Agreement may be weighing on Canadian stocks, along with lingering fears about the country’s housing market and overindebted consumers, Canadian Imperial Bank of Commerce chief financial officer Kevin Glass said in an interview.

“I think all of those things would weigh on Canadian stocks relative to U.S. stocks,” Glass said.

Investors spooked

U.S. investors, who learned hard lessons a decade ago during the U.S. subprime debacle and financial crisis, may be spooked by the rapid growth of mortgages and loans at Canadian banks that fueled overheated housing markets and contributed to near record levels of household debt, according to Edward Jones & Co. analyst Jim Shanahan.

“Although the banks continue to put up these amazing numbers, the stocks never really get away from us because of just broader concerns in the market,” Shanahan said in a phone interview from St. Louis. “There’s an undercurrent of fear in the U.S. as it relates to dramatic growth in residential real estate lending, because we lived through it and it was horrible.”

Still, it’s hard to ignore the superiority of the Canadian banks on measures such as return on equity and profit margins. In these areas, Canadian lenders including Bank of Nova Scotia, Bank of Montreal and CIBC are clear winners.

Canadian bank shares are more expensive than those of U.S. lenders, having fetched a premium over U.S. lenders for a dozen years. The Canadian banks index is trading at about 2.4 times tangible book value per share versus 2.0 times for the KBW Index of U.S. lenders.

“The U.S. economy has been performing very well for the last few years and they’ve had a slightly less difficult regulatory environment to deal with. So it’s normal that they’ve been catching up,” National Bank of Canada chief executive officer Louis Vachon said in an Aug. 29 interview.

A longer-term view tells a different story, he said. Over a 10- or 15-year period “Canadian banks are quite a bit ahead,” said Vachon, the longest-serving of the current crop of Canadian bank CEOs.

Executives such as Royal Bank CFO Rod Bolger say they’re more focused on running the bank than its stock performance.

“If you grow earnings and you grow dividends and if you grow book value per share, which we’re doing, the stock price over the long term will move in tandem with that,” Bolger said.

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